The Investment Industry Regulatory Organization of Canada (IIROC) is stepping up its scrutiny of payout grids and other industry compensation practices, citing concerns about compensation-related conflicts and the industry's heavy reliance on disclosure. The self-regulatory organization (SRO) is asking firms to self-report "double charging" in fee-based accounts and endorsing further regulatory action by its provincial counterparts to address industry conflicts.
IIROC issued a report today spelling out the results of its review of compensation-related conflicts, and pledging further action as a result. The review uncovered "three significant areas of concern," including an excessive reliance on disclosure to deal with conflicts and poor disclosure; a lack of dealer oversight of compensation models and the conflicts they create; and an apparent shift toward fee-based and managed accounts "without appropriate supervision and monitoring."
The SRO says it is investigating any clear breaches of its rules that emerged during the review, which may result in enforcement action. In the meantime, it has issued added guidance today that aims to clarify firms' existing obligations. IROC is intensifying its focus on industry pay practices as part of its compliance reviews, and declared its support for further regulatory action to address conflicts in light of its discovery that disclosure alone is not sufficient.
"While disclosure has generally been accepted by regulators as a way to address conflicts," IIROC states in its report, "our concern is that dealers and representatives are increasingly relying solely on disclosure without ensuring that the conflict has first been addressed in a way that is consistent with [or] considers the best interests of the client, or avoiding the conflict altogether."
The SRO says that its view of disclosure also has evolved alongside research that casts doubt on the efficacy of disclosure and reveals possible unintended consequences.
As a result, IIROC pledged today that it intends to work with the Canadian Securities Administrators (CSA) to ensure that the industry's rules reflect the fact that "disclosure alone is not sufficient to address conflicts, particularly those that are compensation related."
The CSA is currently contemplating reforms to the regulation of client/advisor relationships, including a set of "targeted reforms" to their rules regarding conflicts, proficiency and the industry's use of business titles, as well as the possible introduction of a "best interest" standard and a potential ban on embedded compensation arrangements.
"We agree with the CSA that disclosure alone is a generally inadequate mitigation mechanism because of its limited impact on a client's decision-making process, and that regulatory action is required to better align the interests of registrants to the interests of their clients," IIROC states.
IIROC endorses the CSA's proposed "targeted reforms" and guidance on conflicts of interest: "We are committed to working with them to ensure our requirements are materially harmonized and will be implemented on the same schedule."
At the same time, IIROC has announced that it is "significantly enhancing our exam processes" to ramp up oversight of compensation-related conflicts. As part of these enhanced compliance exams, IIROC says, it will now be looking at payout grids as a standard item in every exam "to determine whether it is product-neutral and unbiased with respect to account type."
The SRO will also be reviewing dealers' efforts to assess compensation risks and their ongoing monitoring; examining the use of sales targets and the conflicts they create; and stepping up testing of dealers' compliance with the requirements under the mutual fund sales practices rule. "We will also take a far more critical look at the appropriateness and quality of conflict disclosure," it says.
A particular focus of these efforts is "double-charging" in fee-based accounts. IIROC says that it recently asked dealers for information about their fee-based accounts, asking them to self-report incidents of "double charging" or cases in which clients' best interests have not been considered.
"Depending on the responses, we will take appropriate regulatory action," IIROC says. "Any failure by a dealer to self-report any issues will result in an automatic referral to IIROC enforcement if we identify significant deficiencies during our next [compliance] exam of the dealer."
This development follows several cases brought by the Ontario Securities Commission (OSC) against large bank-owned dealers, which saw dealers self-report, among other things, overcharging of certain clients.
"As a public interest regulator, we believe that the proper management of conflicts of interest, and compensation-related conflicts in particular, is at the core of the ‘best interest' debate and is critical to improving public confidence in our capital markets and our financial system," says Andrew Kriegler, president and CEO of IIROC. "As a result of these findings, IIROC is immediately taking a number of important steps to make it clear that our rules and guidance put the best interest of the client ahead of the interests of IIROC-regulated firms and their representatives."
Adds Wendy Rudd, senior vice president of member regulation and strategic initiatives at IIROC: "Our targeted review provides us with important insights into how firms are interpreting our rules and what we need to do to ensure that firms have clear policies and procedures to resolve compensation-related conflicts in the best interests of the client."
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